Legal cannabis is a big-money business that could be worth as much as $200 billion in a decade's time, according to projections offered by investment bank Stifel. For context, global sales totaled "only" $10.9 billion in 2018, which demonstrates just how robust growth could be over the years to come.
But as is often the case with next-big-thing investments, they're not without their growing pains. For the legal weed industry, that time is now.
Supply shortages and high tax rates have hurt the North American legal pot industry
Since day one of legalization on Oct. 17, 2018, Canada has been dealing with a shortage of cannabis. Part of this blame can be placed on the growers themselves, mainly because they waited until the passage of the Cannabis Act was a certainty before spending big bucks on capacity expansion projects. As a result, some very large-scale greenhouses are still under construction a year after the green flag waved on adult-use weed in Canada.
However, the bulk of the supply issues in our neighbor to the north have to do with the expediency of approving licenses. Regulatory agency Health Canada entered the year with a monstrous backlog of more than 800 cultivation, processing, and sales license applications that were awaiting review or approval. The agency has implemented stricter guidelines for the cultivation license application process in hopes that it'll reduce its backlog, but this is no quick fix.
Meanwhile, certain provinces have been slow to green-light the opening of retail dispensaries. Without physical dispensaries for consumers to buy from, they're left to either buy online and wait for delivery or purchase from a black market producer. This is a big reason why the black market has been so resilient in Canada, even with a relatively low excise tax rate on legal products.
Comparatively, the U.S. marijuana market has largely disappointed because of high tax rates on legal weed. In California, the state expected to lead all others in annual cannabis sales, the combination of state, local, excise, and wholesale taxes could hit up to 45% in select cities. Plus, with municipalities free to choose whether pot stores can open in their jurisdiction, access to marijuana in recreationally legal states has been spotty.
But there's another danger that's been rearing its head of late: vape-related health concerns.
The vape-related health scare isn't going away
According to a press release from the Centers for Disease Control and Prevention (CDC) in the United States, 1,299 people have confirmed or probable lung illnesses associated with the use of vaping products in 49 states. In total, as of Oct. 8, 26 people have died as a result of these mysterious lung illnesses.
There are two factors that make this scare particularly worrisome.
First, from a health perspective, the CDC is unsure of exactly what's causing these mystery lung illnesses in vape users. What has been noted is that most of the patients who have been diagnosed with these lung illnesses have used a vaporizer to consume tetrahydrocannabinol (THC)-containing liquids. THC is the psychoactive cannabinoid responsible for getting users high. Although the CDC does note that certain individuals with these lung illnesses have used only nicotine-containing cartridges, which doesn't exclude the possibility that this is a nicotine-based issue, the CDC recommends, for the time being, consumers not vape products containing THC.
As a side note, this CDC data and recommendation comes shortly after a New York University study linked vaping to cancer in mice. Understandably, there was nothing concrete about the small sample size of the findings. However, there was a statistically significant difference noted between mice exposed to nicotine-containing vape smoke and vape smoke with no nicotine. In the latter group, none of the 20 mice exposed to non-nicotine vape smoke developed cancer over a four-year period. Comparatively, 22.5% of the 40-mouse subset exposed to nicotine-containing vape smoke developed lung cancer, and 57.5% had precancerous lesions of their bladder, after just 54 weeks.
The second concern is purely financial. As the number of instances of vape-related lung illnesses and deaths rise, vape growth has notably slowed in the U.S. market. That raises near-term and intermediate concerns for the U.S. vape industry, as well as Canada's. As a reminder, derivative pot products, including vapes, become legal in Canada this coming Thursday, Oct. 17, although they won't be available for purchase until sometime in mid-December.
Since vaping sales are expected to lead all other derivative product sales, there's clear concern among investors.
These pot stocks are immune to the vape health scare
Now, for a bit of good news.
Despite these very relevant concerns tied to vaping, there's a trio of marijuana stocks in an ancillary niche of the pot industry that should be completely immune to this health scare. Ladies, gentlemen, and investors alike, say hello to extraction-service providers Neptune Wellness Solutions (NEPT -2.33%), Valens GroWorks (VLNS), and MediPharm Labs (MEDIF 1.67%). And by "extraction," I mean they take cannabis and/or hemp biomass and processes it to yield resins, distillates, concentrates, targeted cannabinoids, and even white-label packaging and products.
What makes these cannabis stocks so unique is that they provide the building blocks of the high-margin derivative industry. Compared to dried cannabis flower, derivatives, such as vapes, edibles, topicals, concentrates, and beverages, generate much juicier margins. Since Canadian weed companies have witnessed what's happened in states like Oregon, where dried flower oversupply and commoditization have hit the legal pot industry hard, each and every major marijuana grower throughout North America has a plan to make derivatives a significant component of their long-term growth strategy. This makes Neptune Wellness, Valens GroWorks, and MediPharm Labs indispensable.
Furthermore, extraction-service companies are operating on a fee-based contract. What that means is pot growers aren't simply coming to these companies with one-time deals. Rather, Neptune, Valens, and MediPharm are locking their clients into 18- to 36-month agreements. These intermediate-term contracts add certainty and predictability to an industry with virtually no certainty and predictability at the moment.
And make no mistake about it, this extraction-service providers has wrangled up an impressive set of clients. Neptune Wellness signed the largest aggregate extraction agreement in history earlier this year: a 230,000-kilo deal with The Green Organic Dutchman spanning three years. Valens, meanwhile, has a two-year agreement in place with HEXO for 80,000 total kilos and a 60,000-kilo-per-year agreement with Tilray. MediPharm's biggest deal to date is a $30 million contract to provide concentrates to Cronos Group over an 18-month period.
The point is that these extracted resins, distillates, concentrates, and cannabinoids are vital for all types of derivatives, and not just vapes, setting this trio of extraction-service providers up for years of success, vaping health scare or not.